Focus Paper no. 2 / 18 January 2017

The 2017 budget within the policy scenario of the public finances

With a renewed spotlight on the request of the European Commission for Italy to correct the public finances in 2017 to reduce the gap to compliance with the path of adjustment towards the MTO provided for under the EU rules, the Focus updates the contents of the 2017 Budgetary Policy Report published last November in the light of the changes introduced during parliamentary approval of the 2017-2019 Budget Act and the Tax Decree (Decree 193/2016, ratified with Law 225/2016). A comparison of the two shows that, with net borrowing unchanged, for 2017 and 2018 revenue has increased by €470 million and €996 million, respectively, while expenditure has risen by €454 million and €981 million.

The Focus examines the policy scenario for the public finances set out by the Government, which is impacted by the modifications to the scale of the budget packet approved by Parliament. The policy scenario is compared with the forecasts issued last November by the Commission and accompanied by the assessment of the Commission in its Opinion on the Draft Budgetary Plan and in the letter transmitted on 17 January, which underscored the need for a structural effort of at least 0.2 percentage points of GDP to avoid the opening of an excessive deficit procedure for non-compliance with the debt rule. The Focus also surveys the main measures of the budget package and the degree of risk to which the public accounts are exposed.

The following offers an overview of the key elements of the PBO assessment, which essentially confirms that set out in the Report last November.

The measures composing the budget package cause the public finances to deteriorate over the three-year period compared with trend developments on a current-legislation basis: this year general government net borrowing is projected to rise from 1.6 per cent to 2.3 per cent of GDP; the deficit is higher than that assumed in the Update (2% of GDP) as three-quarters of the additional margin requested in the Report on the Update and authorised by Parliament is used.

In the Opinion on the DBP from last November, the Commission said it was willing to consider additional deviations in 2017 due to exceptional events, such as expenditure for refugees and seismic events: in the former case, against a request of 0.16 per cent of GDP in temporary deviation from the path of adjustment towards the MTO, the Commission granted 0.15 per cent, although guaranteeing the flexibility for one time only; as regards the second category, the expenditure indicated by the Italian authorities– 0.18 per cent of GDP – is accorded, but in the years after 2017 only positive incremental changes in resources for this purpose would considered eligible for possible additional temporary deviations.

While recognizing the exceptional events, the Commission, on the basis of its own forecasts, pointed out the risk of a significant deviation from the path of adjustment towards the MTO, calling for Italy to resume this path while noting that this was a necessary condition for granting the flexibility in 2016, without which Italy would be exposed to the risk of a significant deviation for that year as well.

In its letter of 17 January, the Commission therefore invites the Italian authorities to provide a public reply including a set of specific commitments and a calendar for a correction of at least 0.2 percentage points in 2017, which would appear to permit achievement of approximate satisfaction of the criteria for non-significance of the deviation in the structural balance and a reduction in the ratio of debt to GDP in 2017 on the basis of the autumn forecasts of the Commission.

Effects of the budget measures and potential risk factors.

The overall impact of the 2017 Budget Act and the Tax Decree approved by Parliament confirm a net deterioration in the net general government balance compared with the current-legislation baseline of about €12 billion in 2017 (0.7 per cent of GDP), €6.6 billion in 2018 (0.4 per cent of GDP) and €2.8 billion in 2019 (0.2 per cent of GDP); the 2017 balance would improve by 0.2 percentage points of GDP without the neutralization of the safeguard clauses regarding VAT and excise taxes (a reduction of about €15.4 billion in revenue).

With resources of €18.2 billion in 2017 and €21.5 billion and €24.3 billion in the two subsequent years, planned uses amount to €30.2 billion in 2017, €28.0 billion in 2018 and €27.1 billion in 2019. On the uses side, the measures increase expenditure for the entire three-year period, especially that devoted to local authorities, pensions, public-sector employment and reviving investment.

Appropriately, a number of measures are intended to revive both public and private investment, which in 2010-2014 contracted by a total of more than 30 per cent compared with 2009: for 2017-2019, public investment is allowed to increase constantly compared with trend levels, with a greater expansion after the reversal in 2015 and the slight growth expected by the Government for 2016.

In 2017, the actions envisaged in the budget package are funded in part with one-off measures, as well as provisions intended to counter tax evasion, whose effectiveness is uncertain. For the subsequent two years, the trend figures are still based on the activation of the safeguard clauses and a reduction in interest expenditure, while the stability of personnel spending due to the lack of contract renewals for public employees can no longer be taken for granted.

For the second consecutive year, the largest measure in the public finance package is the cancellation of the increase in VAT rates for the subsequent year and the same scenario is likely to be repeated if the Government intends to suspend the increases in the following years as well.

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